The Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27, 117 Stat. 752) (JGTRRA) was enacted on May 28, 2003. Subject to certain limitations, the JGTRRA generally provides that a “dividend” paid to an individual shareholder from either a domestic corporation or a “qualified foreign corporation” on or after Jan. 1, 2003 is subject to tax at the reduced rates applicable to certain capital gains. The new capital gains tax rates of either 15% or 5% (15% for shareholders in the top four federal tax brackets, and 5% for shareholders in the 10% and 15% brackets) are a substantial reduction from current rates. The JGTRRA is a complex piece of legislation and the federal government has produced a significant amount of explanatory materials to describe the application of the JGTRRA.
To comply with the JGTRRA, a new Form 1099-DIV was created. Instead of a single box 1 for ordinary dividends, the new Form 1099-DIV includes box 1a for reporting total ordinary dividends that are taxable and box 1b for reporting the portion of the amount in box 1a that may be eligible for the new 15% or 5% capital gains rate, also referred to as “qualified dividends” or “qualified dividend income” (QDI). To qualify for the 15% or 5% capital gains rates, the share of stock to which the dividend relates must be held for more than 60 days of the 121-period that begins 60 days before the “ex-dividend date”. Thus, a “holding period” calculation must be performed as part of the QDI calculation. (The “ex-dividend date” is the first date on which a security is traded without entitling the buyer to receive dividend distributions previously declared. That is, the “ex-dividend date” is the date on which the seller, and not the buyer, of a stock will be entitled to a recently announced dividend.)
JGTRRA applies to individual shareholders whether they own shares of stock directly in a brokerage account or whether they own shares of stock indirectly by virtue of owning shares in a mutual fund that holds securities. Thus, each mutual fund must now calculate the percentage of its ordinary dividend income that is QDI. Some types of ordinary dividends that will not be QDI (and thus are not eligible for the reduced tax rates) include:
1. Dividends earned on stock that was not owned for long enough to meet the holding period (e.g., short-term capital gain distributions).
2. Interest from bonds and money market securities.
After a mutual fund determines the percentage, it will be used to calculate the QDI for each investor that is reported on the new Form 1099-DIV.
A mutual fund investor cannot automatically presume that the entire amount of QDI reported in box 1b of the Form 1099-DIV is entitled to the new 15% or 5% capital gains rate. This is because all of the dividend producing mutual fund shares owned by the individual investor may not have met the holding period requirement. That is, even though the mutual fund held the shares long enough so that the dividends are QDI with respect to the mutual fund, an investor may not have held their mutual fund shares for the required period of time such that the dividends are QDI in the hands of the investor. Accordingly, each mutual fund investor has its own “personal qualified dividend income” (personal QDI) which will be an amount between $0 (e.g., an investor who purchased all of their mutual fund shares within weeks of when dividends were declared) and the entire QDI (e.g., an investor who has not bought any new shares in the past year). The personal QDI is not reported on the Form 1099-DIV and there is no requirement for mutual funds to calculate what the personal QDI should be for a specific investor. It is estimated that a significant percentage of accounts managed by a mutual fund investment provider (perhaps 8-15% will have a personal QDI each year that differs from the fund QDI.